Asset management ratios help to understand how effectively the business uses its assets to generate revenue. It’s an essential ratio for the business stakeholders to assess if management is actively using the assets.
As these ratios measure the efficiency of revenue generation, the same is the reason that these ratios are also called efficiency/turnover ratios. It’s important to note that these ratios only use revenue and assets as input in the calculation. So, it’s a comparative study to find some relation between the revenue and total assets of the business.
Purpose of calculating asset management ratios
The purpose of calculating the asset management ratio is to assess the business’s financial performance with perspective to the management of activities. The concept is simple if the business can effectively manage their assets, they are expected to present better financial performance.
So, potential investors not only look for better profitability but business competence to manage operational activities.
Types of the asset management ratios
The most common types of asset management ratios include total assets turnover, working capital turnover, inventory turnover, receivables turnover, payable turnover, and day’s sales in inventory, etc. Let’s discuss these types in further detail.
1-Total assets turnover ratio
This ratio compares sales generated by the company with total assets as we understand that the business with a higher asset base is expected to generate higher revenue in general. So, this ratio enables stakeholders to compare the revenue-generating ability of the business with other businesses and helps in deciding on an investment.
This ratio is calculated with the following formula.
Asset turnover ratio = sales / Total assets
2-Working capital turnover ratio
This ratio helps to understand how effectively the business utilizes its implied working capital to produce revenue. A higher value of working capital is desirable from an investor’s perspective as it indicates enhanced efficiency.
The ratio is calculated with the following formula.
Working capital turnover ratio = Net annual sales of the business / Average working capital implied
It’s important to note that implied working capital costs money in terms of financial and opportunity costs. So, higher revenue with less working capital is a desirable feature with perspective to investors.
3-Fixed assets turnover ratio
This ratio compares sales generated by businesses with fixed assets, and the concept is the same as in the case of total assets turnover. Hence, a business with higher sales is considered better in terms of efficiency.
This ratio is calculated with the following formula.
Fixed assets turnover = sales / Total fixed assets
However, it’s important to note that some businesses are established with very low Net Book value of the fixed assets and indicate the higher value of the asset turnover ratio.
So, adding small details in the analysis helps perform a better financial analysis of the potential investment opportunity.
4-Inventory turnover ratio
The inventory turnover ratio aims to assess how quickly inventory is used and replaced by the business. If the inventory turnover ratio is higher, it indicates that inventory is replaced more frequently, and less cost is incurred for the working capital management.
The ratio is calculated with the following formula.
Inventory turnover ratio = Cost of goods sold / Average inventory
5-Receivable turnover
The receivable turnover ratio helps to assess the efficiency of the collection function. A higher value of the receivable turnover ratio helps to understand that the business has quality customers that pay their debt on time. On the other hand, lower receivable turnover indicates inefficient funds collection, the inadequacy of credit policy, and problems with the financial status of the customers.
The ratio is calculated with the following formula.
Accounts receivables turnover ratio = Net credit sales / Average accounts receivables
6-Days sales outstanding – DSO
Days sales outstanding ratio helps to measure the efficiency of the collection function in terms of the number of days. The lower value of DSO indicates that the collection function is efficient in recovering funds under debt. On the other hand, a higher value of DSO indicates the business needs to improve its collection.
The ratio is calculated with the following formula.
Days sales outstanding = Average accounts receivables / sales x 365
7-Payable turnover ratio
The payable turnover ratio is not directly asset management ratio. However, it helps to assess the performance of the business in terms of working capital management. Decreasing Accounts payable turnover indicates that the company takes greater time to pay off its obligations, and it may signal a liquidity problem with the business. Alternatively, it can be perceived that the business is efficiently managing its suppliers.
On the other hand, a high value of payable turnover ratio indicates that the business is successfully managing the cash flow. Alternatively, it can be perceived that the business may not be able to negotiate with the suppliers on terms of payment.
This ratio is calculated with the following formula.
Accounts payable turnover = Total supplies purchases / Average accounts payable
Conclusion
Assets management ratios help to assess the efficiency of the business’ operational activities. It helps to understand how the business has been using resources allocated in the business. Potential investors and other stakeholders desire to work for the business with higher efficiency and effectiveness.
These ratios help in the overall financial analysis of the business and provide an in-depth understanding of the operational business processes. Further, these ratios can be assessed in terms of total assets and the break up like inventory, receivables, and other assets.
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